Obama Trying to Take Over Student Loan Biz, Adding Another Trillion to the Debt

Whats one more trillion dollars between friends. At least it seems that’s what the POTUS thinks. While everybody has their eyes on the Health Care Issue which will add up to one trillion dollars to the national debt, the President has been maneuvering to have the government to to take over the student loan business. Starting next year the President wants to bar private lenders to make government backed, student loans. This take over will add another trillion dollars to the debt over a ten year period.

The furor over President Obama’s trillion-dollar restructuring of American health care has left his other trillion-dollar plan starved for attention. That’s how much the federal balance sheet will expand over the next decade if Mr. Obama can convince Congress to approve his pending takeover of the student-loan market.

The Obama plan calls for the U.S. Department of Education to move from its current 20% share of the student-loan origination market to 80% on July 1, 2010, when private lenders will be barred from making government-guaranteed loans. The remaining 20% of the market that is now completely private will likely shrink further as lenders try to comply with regulations Congress created last year. Starting next summer, taxpayers will have to put up roughly $100 billion per year to lend to students.
***

For decades, loans carrying a federal guarantee have been the most common way of borrowing for college. After raising money in the private capital markets, lenders made the loans, paying a fee to the government for each one. The government covered most of the cost of defaults while allowing the private lenders to make a regulated return.

The system broke down after Congress in 2007 legislated a return so low that no private lenders could make money holding these assets. To keep the money flowing to student borrowers, the government began buying the loans from private originators last year. But this larger federal role was intended to be temporary, with an expiration date next summer. The news from Washington now is that rather than scaling back federal involvement, the pols want the U.S. Department of Education to be the exclusive banker to America’s college students.

It’s not a popular idea on campus. Loans directly from the feds have been available for decades, but the government’s poor customer service has resulted in most borrowers choosing private lenders. This week three dozen college administrators, representing schools from Notre Dame to Nevada-Reno, signed a letter urging a longer transition period to this “public option.” The fear is that the bureaucrats will not be able to pull off a takeover in just eight months. “Any delay in getting funds to schools on behalf of students will result in our needing to find resources at a time when credit is difficult to obtain,” warns the letter.

Tough luck for the Irish. Democrats have already greased this fall’s budget reconciliation to pass all of this on a mere majority vote. They are helped by rigged government accounting that disguises the cost of making below-market loans to unemployed 18-year-olds. Democrats have claimed their plan “saves” $87 billion in mandatory spending by cutting out the private middlemen, and the Congressional Budget Office has dutifully “scored” $87 billion in mandatory “savings” (or a net of $80 billion after subtracting administrative costs).

But in a remarkable letter to Senator Judd Gregg, CBO Director Douglas Elmendorf admits that government accounting is bogus. He writes that the statutory methodology “does not include the cost to the government stemming from the risk that the cash flows may be less than the amount projected (that is, that defaults could be higher than projected).” Mr. Elmendorf further notes that the government’s accounting system is specifically skewed to make direct loans from the government appear to cost much less than guaranteed loans made by private lenders. He says the real “savings” are only $47 billion, even though, in a deception that would be criminal fraud if it weren’t mandated by Congress, the official estimate remains at $80 billion.

Even the unofficial number is dubious. The government has been claiming lower default rates than private lenders, but most government loans have been to students at four-year colleges. The private lenders have serviced a higher percentage of students at community and two-year colleges, where defaults are more common regardless of lender.

If the feds are now making and owning all such loans, expect default rates to soar. When the government hires contractors to collect on its loans, it pays them for simply calling the borrower, regardless of the result. Private lenders, on the other hand, make money from a performing loan and have a greater incentive to do careful underwriting and aggressive collection.
***

The government will nonetheless start spending these illusory “savings” immediately, and this spending is certain to top official estimates. The Obama plan also adds a CBO-estimated $46 billion in new spending over 10 years to enlarge Pell grants. Ominously for the federal fisc, starting in 2011 these grants will automatically rise each year by the consumer price index plus 1%. Not that students will actually benefit from this subsidy explosion. Colleges have reliably raised prices to capture every federal dollar earmaked for education financing.

Rep. John Kline (R., Minn.) decided the cost estimate for Pell grants was too low, so he asked CBO to take a second look. Along comes another enlightening letter from Mr. Elmendorf. This week he wrote that Mr. Kline is correct—it looks like they will cost another $11 billion. Unfortunately, the earlier estimate must remain the official score under budgeting rules, even though the official scorekeeper says it is wrong.

All of this is certain to pass the House, and the only chance for stopping it is in the Senate. If it passes, parents will soon have no choice beyond a Washington bureaucracy to borrow money for their college-bound children, and taxpayers will pay a fortune for the privilege.

Become a Lid Insider

Sign up for our free email newsletter, and we'll make sure to keep you in the loop.